It was shaping up as another bad day for stocks, which have once again been spooked by the lack of de-escalation in the US-China trade war (as reported yesterday, the S&P would have to drop below 2,650 for that to happen), when Iran - as Trump will soon allege - came to the bulls' rescue, and "attacked" two tankers in the Straits of Hormuz, sending oil soaring and pushing energy stocks - and European stocks and US equity futures - higher, even as bond yields dropped amid a general flight to safety.

Brent surged as much 4% after the attacks added to the already-heightened tensions between Iran and the United States. And of course, given that oil was at 5-month lows yesterday, people are taking precautions that it might escalate into something further.

“Whenever you have an incident in the Arabian Gulf a little bit of nervousness always starts to kick in about that particular artery getting clogged up,” CMC Markets senior analyst Michael Hewson said. "But personally I think it will be much like in the past where you get a spike higher but ultimately it doesn’t change the underlying supply and demand dynamics,” Hewson said.

The area is near the Strait of Hormuz through which a fifth of global oil consumption passes from Middle East producers.

“Whenever you have an incident in the Arabian Gulf a little bit of nervousness always starts to kick in about that particular artery getting clogged up,” CMC Markets senior analyst Michael Hewson said.

The European Stoxx 600 Index opened in the red following a second day of declines across Asia, but it went on to reverse losses, and contracts on the three main U.S. gauges tracked the move, as oil exploded higher helping propel energy stocks on both sides of the Atlantic. Europe’s oil producers moved higher in the region’s stock markets. Shares were also lifted by some stellar gains in the telecoms sector as Germany dished out licenses for its new 5G mobile network to some new entrants

There was plenty of caution remaining however, and Treasuries continued to tick up alongside European government bonds.

Earlier in session, Asia was a different story. Hong Kong’s Hang Seng had dropped sharply for a second day as public tensions continued there about a bill which would allow extradition to China, with most major markets in the region down. The Hong Kong legislature scrapped a meeting to discuss the extradition bill, according to a statement on its website. China stocks erased an early decline to rise 0.1% in a steep rebound that showed the plunge-protecting "National Team" stepped in to rescue stocks. Technology was the biggest drags on the region’s benchmark stock index. Asian semiconductor stocks joined a global selloff in chip stocks, as Evercore ISI warned that a recovery in demand for memory chips may not pick up until the second half of next year.

Doubts also have been growing about any improvement in what U.S. President Donald Trump called ‘testy’ trade relations with China before this month’s G20 summit and some market anxiety emerged that Federal Reserve rate cut speculation may have been overdone.

Investors will be looking to what the FOMC will say after its next policy meeting on June 18-19, with Fed Funds rate futures pricing in a 25-basis-point rate cut for the subsequent policy review on July 30-31. That is 180 degrees opposite to the Fed’s projection three months ago, when policy makers saw gradual rate hikes in coming years.

“The U.S. real economy has not worsened that much. But given market expectations, the Fed will have no choice but to cut rates,” said Kozo Koide, chief economist at Asset Management One.

In rates, the 10-year U.S. Treasuries yield dipped to 2.103%, near Friday’s 2.053%, its lowest level since September 2017, while Germany borrowing costs sank back toward all-time lows in Europe. Bond yields also fell in Asia. Long-dated Japanese government bond yields hit their lowest levels since August 2016, with 20-year yield down 2.5 basis points at 0.220 percent, before they rose back on a weak 30-year bond auction. In Australia, long known for its high-yield currency, rates fell to record lows, with three-year yield dropping below 1% for the first time ever, after jobs data pointed to another interest rate cut in July to follow one last week.

In currencies, the dollar was stuck in a tight range, the Swiss franc advanced as the SNB kept rates and verbal guidance unchanged, and the yen gained 0.2% to 108.32 to the dollar as risk sentiment soured while the Australian dollar dropped 0.25% to $0.6910. The euro stood little changed at $1.1293, having taken a hit on Wednesday after Trump said he was considering sanctions over Russia’s Nord Stream 2 natural gas pipeline project and warned Germany against being dependent on Russia for energy. The pound stayed subdued after British lawmakers defeated an attempt led by the opposition Labour Party to try to block a no-deal Brexit by seizing control of the parliamentary agenda from the government.

Oil held its biggest daily loss this month to trade near $51 a barrel as a surprise increase in American crude inventories and no sign of a breakthrough in the U.S.-China trade war damped sentiment

Just a few hours later oil prices surged after the U.S. Fifth Fleet said two oil tankers were damaged in an incident near the Strait of Hormuz -- one of the ships’ operators described the incident as a suspected attack. The development will inflame already-rising political tensions in the region

The Democratic National Committee has a money problem that could hurt its nominee’s chances of beating President Donald Trump in 2020. In the first four months of 2019, the party spent more than it raised and added $3 million in new debt while its Republican counterpart was stockpiling cash

President Donald Trump said he had no deadline for China to return to trade talks, other than the one in his head

The prospect of the U.K. crashing out of the European Union in October is now a “very serious” risk, a senior Irish foreign ministry official said

Australia’s jobless rate held above 5% in May despite a surge in hiring, underscoring the Reserve Bank’s challenge to drive down unemployment and stoke inflation

President Trump upped his criticism of Germany on Wednesday as he threatened sanctions over Angela Merkel’s continued support for a gas pipeline from Russia and warned that he could shift troops away from the NATO ally over its defense spending

Hong Kong lawmakers scrapped debate for a second straight day on legislation that would allow extraditions to China, as tensions remained high between police and protesters after violent clashes on Wednesday

Conservative Members of Parliament will cast ballots Thursday in the first round of voting to find a successor to U.K. Prime Minister Theresa May, a day after the favorite, Boris Johnson, played it safe by softening his tone on Brexit and promised to stand up for business

A downshift in the world economy and a dovish pivot by other central banks is boosting the haven franc, meaning the The Swiss National Bank is stuck with its dual tack of record-low interest rates and unwavering intervention threats for some time

One of Hong Kong’s top business groups called on Carrie Lam’s administration to “engage in meaningful dialogue with the public,” saying mass protests show the city is wary about the current version of a controversial extradition bill

Asian equity markets traded relatively flat/mixed following an uninspiring performance on Wall St where all major indices extended on losses as trade uncertainty lingered, with the downside led by energy and financials after a further decline in oil prices and yields. ASX 200 (Unch.) and Nikkei 225 (-0.5%) were subdued but with losses in Australia stemmed as mixed jobs data supported the case for further rate cuts by the RBA, while the Japanese benchmark was pressured as energy names suffered the brunt from the recent 4% drop in crude and with the nation’s largest megabank MUFG weighed as it faces its first ever Q1 loss due to a JPY 300bln impairment related to its Indonesia JV. Hang Seng (U/C) and Shanghai Comp. (+0.1%) were initially weaker after the recent miss on lending data, as well as ongoing trade uncertainty with President Trump continuing to send mixed signals regarding a trade deal and as the Chinese government mouthpiece Global Times suggested Beijing is preparing for ties worsening. Hong Kong underperformed again amid disruptions following the mass protests and as the Legislative Council was set to hold a meeting regarding the extradition bill today, although this was later postponed, and stocks gradually rebounded from lows. US equity futures were also active and deteriorated overnight amid the widespread risk averse tone and technical selling in which DJIA futures slipped below the 26k level and E-mini Nasdaq 100 pulled back from resistance at 7.5k. Finally, 10yr JGBs were initially higher as the weakness across stocks spurred a flight to quality and amid the declining global yield environment, although the gains in bonds were aggressively pared after an abysmal 30yr auction in which the b/c printed its lowest since November 2017 and the tail in price spiked to 0.87 from 0.03.

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European equities are higher across the board [Eurostoxx 50 +0.4%] as the region deviated from the subdued Asia-Pac lead. Sectors are all in the green with the energy sector outperforming (+0.6%) amid the surge in energy prices as two oil tankers were reportedly attacked near the key shipping channel, the Strait of Hormuz (see the Commodities section for a full briefing). Meanwhile, some defensive sectors are lagging its peers with the likes of Utilities (+0.1%) and Consumer Staples (Unch) little changed. Elsewhere, Germany’s 5G auction ended in which raised EUR 6.55bln, above estimates of EUR 3-5bln. Four companies won bids: Deutsche Telekom (+0.7%) won 130MHz, Vodafone (+1.1%) won 130MHz, Telefonica Deutschland (3.5%) won 90MHz and 1&1 Drillisch (+7.5%) won 70MHz. In terms of individual movers, Thales (+2.3%) shares are supported after the Co. raised its EBIT outlook. Wirecard (+3.2%) rose to the top of the DAX amid a positive broker move. On the flip side, ProsiebenSat1 (-3.9%) fell to the foot of the Stoxx 600 amid ex-dividend trade.

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In currencies, flanking the G10 ranks after the SNB refrained from raising its assessment of the Franc from highly valued despite acknowledging that the currency has appreciated since the last quarterly policy review in March and repeating the need to maintain NIRP and intervention. Board members also noted elevated risks of heightened demand for the Chf, more pronounced downside risks to the Swiss economy due to external and reiterated that there is room to loosen the monetary reins further, but signalled steady rates through the 3 year forecast horizon. Note, the 3 month Libor target and range was replaced with a new benchmark rate, but for purely technical reasons and the impending switch from Libor to SARON. Usd/Chf and Eur/Chf are both lower in wake of the policy pronouncements, statement and revised forecasts for growth and inflation, with the former retreating towards 0.9900 again and latter eyeing 1.1200. Conversely, the Aussie has been undermined by mixed labour data that underpins prospects for another RBA rate cut, with Aud/Usd hovering just above 0.6900 and Aud/Nzd only a few pips away from 1.0500. For the record, headline payrolls beat consensus, but mainly due to temp jobs and the unemployment rate remained unchanged against forecast for a dip, while decent option expiries at 0.6930 look fairly safe at this stage.

CAD/JPY - The Loonie and Yen are both firmer vs the Greenback amidst an escalation in US-China trade angst and geopolitical concerns, with Usd/Cad easing back between 1.3343-14 parameters and Usd/Jpy holding in a 108.53-17 range. A relatively sharp rebound in crude prices on reports of tanker attacks in the Gulf of Oman has underpinned the Loonie, while the Yen is benefiting from a degree of safe-haven positioning, like the Franc and Gold, but also wary of balanced expiry interest given 1.5 bn running off from 107.90-108.10 and 1.6 bn between 108.65-80.

EUR/NZD/GBP - Narrowly mixed vs the Buck as the DXY nestles near 97.000 after the post-US CPI bounce, but is capped ahead of resistance just above the round number in the form of 100 and 10 DMAs (97.020 and 97.033 respectively). The single currency is pivoting 1.1300 having failed to close above Fib resistance at 1.1338 on Wednesday, with support coming in around 1.1280 and option expiries nearby at 1.1310-30 (1.1bn) then 1.1345-60 (1.2 bn). Elsewhere, the Kiwi is seeing some bearish contagion from its Antipodean counterpart, but holding up better vs the Usd within a 0.6587-65 band ahead of NZ manufacturing PMI. Meanwhile, the Pound has lost grip of 1.2700 vs the Usd and Eur/Gbp is back over 0.8900 on no deal Brexit risk in the run up to the start of the Tory leadership race and first elimination vote.

EM - The Lira has given up more post-CBRT gains and is now somewhat weaker than it was prior to the policy meet on latest remarks from Turkey reaffirming intentions to go ahead with the Russian S-400 order, and as the Defence Minister claims that Syrian Government forces attacked a Turkish observation post in Idlib. Usd/Try has rebounded towards 5.8500.

In commodities, WTI and Brent futures surged higher in early European trade and have held onto most of their gains amid a number of bullish headlines for the oil complex: 1) a UAE Port Official stated that an oil tanker is currently on fire in the Gulf of Oman, with subsequent reports indicating that two oil tankers (of which one belongs to a Japanese shipping company, and is carrying chemical materials) have been attacked by torpedoes, although no one has yet claimed the attacks. Analyst point out that the magnitude of the spike in energy prices could be attributed more to the location of the attack, i.e. close to the Strait of Hormuz (a key shipping channel), for reference, four oil tankers have been damaged in the same area in the last month. Fingers have been pointed at Iran for last months attacks, although Tehran has denied any involvement. 2) On the OPEC front, reports stated that Kazakhstan has reduced its oil output to 1.76mln BPD for the January to May period, which exceeds their obligations under the current OPEC+ pact. The oil producer has also indicated support for an extension to the OPEC+ deal, whilst Algeria has also floated the idea of an OPEC+ supply cut of 1.8mln BPD (currently 1.2mln BPD) in H2. 3) Russian President Putin stating that relations with the US are worsening, which comes in the context of US President Trump stating overnight that he is considering sanctions to block the Nord Stream 2 pipeline, and indicating that Germany is at risk by depending on energy from Russia. Brent futures currently reside around the USD 61.75/bbl mark, having opened trade sub-60/bbl and hit a high of around USD 62.60/bbl thus far.

As the UK ponders over when summer will finally decide to return, the grey clouds that continue to gather over the Federal Reserve appear to show little sign of dissipating any time soon. That said, the market isn’t giving the Fed much hope of skipping straight to autumn with futures continuing to price in high odds of a rate cut this summer with as good as a full 25bp cut priced in for the July meeting. Yesterday’s soft CPI report – which we run through in more detail below – was the latest fuel for the fire. At the same time, Commerce Secretary Ross was the latest US administration official to be given a free hand to attack the Fed, calling the December rate hike “at best premature” and the Fed “more aggressive in interest rates than the facts really warranted”. Ross was a bit more coy about trade talks, suggesting that the US and China may decide “it’s worth reopening” talks at the G-20 meeting later this month but also that it won’t be used as a forum for the sides to sign a final accord.

In light of the recent developments, yesterday our US economists updated their economic and Fed forecasts. They revised down their 2019 growth forecast by 0.4pp to 1.9% and their core PCE inflation forecast by 0.1pp to 1.8%. In response, they now expect the Fed to cut interest rates three times this year, at each of the July, September, and December meetings. That easing will likely feed through into growth over the following quarters, so they upgrade their 2020 forecast by 0.3pp to 2.2%. Their full update is available here .

Back to markets, where, when it was all said and done, the biggest price action was unsurprisingly in rates where 2y Treasury yields fell -5.1bps and 10y yields -2.3bps. The move was mostly driven by a drop in inflation breakevens, as oil prices fell sharply after US inventory data showed a 2.2mn barrel build in stockpiles despite expectations for a drawdown. WTI crude fell -4.05% to $51.11 per barrel. In other risk assets, with a potentially nervous 6 days until the crucial upcoming Fed meeting, equities have definitely taken their foot off the pedal with the S&P 500 dipping back -0.20% by the end of trading last night. The NASDAQ also ended -0.38% and DOW -0.17%. The move in oil prices drove a -1.44% decline for the energy sector, while tech and bank shares also lagged. The former were negatively affected by idiosyncratic company news, with Tesla’s (-3.61%) latest guidance disappointing and the WSJ reporting that senior executives at Facebook (-1.72%), including CEO Mark Zuckerberg, knew about privacy lapses as far back as 2012. Bank stocks in both the US and Europe fell as well, down -1.41% and -1.18% respectively, as the renewed drop in bond yields proved a negative for the sector.

For the most part this morning, equity markets in Asia are following Wall Street’s lead with the Nikkei (-0.81%) and the Kospi (-0.73%) leading the declines. We should note that protests in Hong Kong have continued overnight, with Hong Kong’s Cable TV reporting that the Legislative Council won’t be debating the extradition bill today. The Hang Seng has pared back losses to trade -0.74%, having been down as much as -1.77% earlier in the session, while the Shanghai Comp is now in marginally positive territory (+0.12%). At the moment the US administration has remained fairly tight lipped about the protests, as President Trump gave a fairly noncommittal comment that he hopes the two sides can “work it out.” However White House Counsellor Conway did say yesterday that Trump may bring it up with China at the G-20 and the argument is that any interference would likely heighten tensions between the US and China at what is clearly already a very tense time. So it’s a situation which is worth following. Alongside the US-China uncertainty, Trump also re-injected doubts concerning the recent agreement with Mexico, saying that he could still take punitive action in 45 days if he chooses. He also threatened Germany with sanctions over the controversial Nord Stream 2 pipeline, though those would likely be targeted on involved companies rather than blanket tariffs.

Staying with politics, Sterling fell -0.28% yesterday after the House of Commons voted 309-298 against a motion brought forward by the Labour Party that would have allowed MPs to take control of the parliamentary timetable on 25 June, to presumably pass legislation that would prevent a no-deal Brexit. The current legal default requires the UK to leave the EU on 31 October, with or without a deal. A number of Conservative leadership candidates – including front-runner Boris Johnson – have said that if a deal can’t be reached, they would favour proceeding without a deal so as to honour the October deadline. However, this is unlikely to be the last attempt to stop no-deal, and the House of Commons has already voted on a non-binding motion to reject a no-deal Brexit back in March. The attempts to stop no-deal come at an important moment in the race for the Conservative leadership, with the first ballot of Conservative MPs being held today. The ballot will take place this morning and we expect to get a result around 1pm UK time. The 10 candidates each need at least 5% of the votes to progress to the second ballot on Tuesday, and if all of the candidates reach the 5% threshold, the one with the least support will be eliminated.

Coming back to the data, as mentioned the US CPI report was soft with the +0.11% mom core print below expectations for +0.2% and in the process lowered the annual rate to +2.0% yoy, while the 3-month and 6-month readings also dropped to +1.6% and +1.9% respectively. The trimmed mean measure, which excludes outliers and had been cited by Powell as evidence that soft inflation has been transitory, also slid to 0.11% mom, its weakest reading in two years. So the weaker momentum is clearly significant and makes it harder for the Fed to pass off the misses as solely transitory. The softness was centred around transportation and recreation and the read through suggests further downside for the core PCE reading also. The other US data was the monthly budget statement, which showed a monthly deficit of -$207.8bn, which was actually the widest-ever May deficit reading in dollar terms on record. So far this fiscal year, the US budget is on track for its widest deficit since 2011. Finally, US mortgage applications rose 26.8% wow last week, which was the fastest pace since January 2015, as lower interest rates seem to be feeding through to housing activity.

In other news, an MNI story yesterday suggested that a certain number of ECB officials had suggested that QE may return if necessary, however other officials had concerns over bond limits and that no major policy action is likely during the remainder of Draghi’s term. Separately, bank of France Governor Villeroy said that the ECB can do more if conditions deteriorate, and suggested that they have not yet achieved their price stability target. That latter view has certainly been supported by the market, with the five year-five year inflation swap rate dipping below 1.2% to a new all-time low.

The debate about restarting asset purchases will certainly remain in focus for the next several months, especially if the Fed ends up cutting interest rates as our economists now expect, and DB’s Michal Jezek has a new note out detailing his analysis of what credit markets are pricing for the ECB, available here . For completeness, in Europe yesterday the STOXX 600 finished -0.30% yesterday while Bund yields fell -0.4bps. BTPs (+4.1bps) again underperformed after the Italian treasury successfully sold €6bn of 2040 bonds, with investors possibly hedging their new positions by selling shorter-dated BTPs. The move came despite more positive mood music between the EU and Italy, as Prime Minister Conte told reporters that he is drafting a response to the EU which will reportedly aim to defer any actions until after the summer.

To the day ahead now, where shortly after this hits your emails we’ll get the final May CPI revisions in Germany and then the April industrial production print for the Euro Area. Across the pond the only data due is the May import price index reading and latest claims print. Away from that we’re due to hear from the BoE’s Carney this afternoon while the aforementioned Conservative Party leadership contest will also be closely watched. Meanwhile, Euro Area finance ministers will gather in Luxembourg to discuss Italy and the Euro Area budget.